Payroll is often a company’s most significant expense. Unfortunately, theft within the payroll system can result if internal controls are not in place and steps are not taken to detect fraudulent activity in the company’s records. But there is good news: Payroll fraud in all forms is largely preventable.

Typically, payroll schemes involve fraudulent payments being unwittingly made by a company to an existing employee, a previous employee, or the accomplice of an employee. The following three schemes represent the most prevalent types of payroll fraud in all industries:

1. Eerily absent employees. “Ghost” employees receive regular paychecks, yet they do not actually provide any services at a company. A ghost employee can be a real person who no longer works at the business but has not been removed from the payroll records. It could also be a fictitious person who never worked there or an accomplice of an actual employee. Depending on whether a ghost employee is classified as hourly or salaried, time sheet approval may be needed prior to a paycheck being generated. Often, a thief sets up a bank account to direct deposit the check.

2. Employees with too many hours yet too little time. An hourly employee’s compensation is determined by two factors: the employee’s hourly rate and the number of hours that they actually work. Hourly employees typically do not have the access or the authority to change their hourly rate, therefore, the number of hours worked is the factor that is manipulated.

Time worked is normally derived from a time clock, log on and log off times in a computer, or a manual system compiled and approved by employees’ supervisors. Depending on the time tracking system in place, an employee, a supervisor, or someone in the payroll department could change or approve the reported hours that were supposedly worked. The overstated time report is then submitted for payment, which is disbursed to the perpetrator.

3. Commissioned employees committing fraud. In many organizations, employees in the sales department are compensated based on the volume of sales they produce or the income that actually results from sales. In order to commit fraud, a commissioned employee must either exaggerate the level of sales generated or overstate the rate at which commissions are supposed to be paid. Without additional review and verification, the inflated sales and altered commissions are entered into the payroll system and disbursement of the fraudulent payment is triggered.

To prevent payroll fraud in all its forms, consider engaging a forensic accountant to review the following aspects of your payroll system:

Segregate duties. The preparation, distribution, and reconciliation of payroll expenses should generally be segregated among different employees at your firm. If any of these duties are currently performed by the same employee, that individual likely knows about any weaknesses in the payroll system. Consider reassigning the duties to avoid the type of collusion that can facilitate fraudulent payments.

Data mine payroll disbursement records. For payroll fraud to occur and someone to profit, the fraudster must receive a check. Consequently, company records usually contain the data needed to unravel fraud. For example, is there more than one employee with the same address? Does more than one employee deposit a paycheck in the same bank account? Forensic accountants analyze data including a check of payroll lists of employee addresses, start and termination dates, Social Security numbers, and other factors.

Ensure company policy compliance. Make sure to follow strict policies surrounding payroll. For example, are all new employees subjected to a background check? Are wage rates authorized by the designated officials in the company? Are sick leave, holidays, and vacations approved and recorded appropriately in the payroll system? Do exception reports exist and are they reviewed regularly? Are payroll disbursement accounts routinely reconciled and all exceptions investigated by suitably trained professionals?

The evidence of payroll fraud is often hidden in plain sight because the transactions look legitimate. It can take a concerted effort to combat, but the results will be lower payroll costs and the comfort of knowing that your company is not paying employees who have not earned the money.

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Our firm provides the information in this article for general guidance only, and does not constitute the provision of legal advice, tax advice, accounting services, investment advice or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal or other competent advisors. Before making any decision or taking any action, you should consult a professional advisor who has been provided with all pertinent facts relevant to your particular situation. Tax articles in this blog are not intended to be used, and cannot be used by any taxpayer, for the purpose of avoiding accuracy-related penalties that may be imposed on the taxpayer. The information is provided “as is,” with no assurance or guarantee of completeness, accuracy or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability and fitness for a particular purpose.




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